Corporate Forms for Insurance Businesses

What corporate form should you choose if you are starting an agency or brokerage insurance business?  The most obvious choices are a C corporation, an LLC, or an S corporation (as they are commonly referred to).  S corporations were a widely used corporate form for small business, LLCs have their advantages and are highly popular, and the traditional C corporation has its own practicalities.  Sole proprietorships and partnerships are sometimes used as well, but these days neither is ideal for a new insurance agency or brokerage business.

Both LLCs and S corps are pass through entities for tax purposes, but LLCs generally have more flexibility.  Here are some of the pluses and minuses of each for consideration, and some sources of additional information.

LLCs are generally considered the best structure for tax purposes due to the pass through feature and their flexibility.  This is especially important in a sale of the business because insurance agency buyers generally want to buy assets, not the corporate entity.  With an LLC form, a sale of assets is taxed at the member level, not at the LLC level.  However, members of LLCs are considered self-employed, and will be subject to employment taxes.

While the sub-S corporate structure provides the income tax pass through feature of an LLC, there are more restrictions on who can be owners.  While this may not be an issue at startup, the structure can impact subsequent capital raising and strategic partnership efforts.  Salary compensation paid to the owner is subject to employment tax and the rest is paid as a distribution.  This can be an advantage, but is also a complex area subject to IRS scrutiny for abuse.

The traditional C corporation structure has the disadvantage of no tax pass through, which creates a double taxation on any distributions beyond compensation.  Therefore, it is hard distribute profits to owner without excessive taxation.  Dividends are double taxed – they are taxed at both the corporate level and at the investor level.  In addition, a sale of assets is double taxed in a corporation as well, which means it is imperative that the buyer agree to acquire the entity.  Insurance buyers typically do not want to buy the corporate entity, just the agency or broker business & other assets.

A new issue for pass through entities in the insurance business may be coming as states look for new sources of revenue.  Insurance agencies and brokers licensed as non-residents may become subject to income taxes on business originating in these non-resident states even if the agent or broker has no presence in the state.  For example, California has revised its approach (see here):

California has adopted a new "doing business" standard beginning 1/1/2011 which will impact taxpayers, including corporations, pass-through entities and their owners.  Owners of pass-through entities that did not have nexus before may have nexus starting in 2011.

The filing of multiple state income tax returns for each member of an LLC will be an undue burden on the LLC, and therefore a more traditional C corporation form may be preferable.

Additional Sources of Information:

S Corps vs LLCs (see here, here & here)
S Corporations
LLC vs C corp
Table Comparison of Entities
New York Discussion
S Corp Tax Increase
California Tax Changes (see here, & especially here and here)

Specialty Insurance Expertise: Tennant Risk Services
Supporting Insurance Entrepreneurship: Tennant Capital Partners

 

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